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INTERCLOUD SYSTEMS, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) This management's discussion and analysis of financial condition and results of operations contains certain statements that are forward-looking in nature relating to our business, future events or our future financial performance. Prospective investors are cautioned that such statements involve risks and uncertainties and that actual events or results may differ materially from the statements made in such forward-looking statements. In evaluating such statements, prospective investors should specifically consider the various factors identified in this report, including the matters set forth under Item 1A "Risk Factors," which could cause actual results to differ from those indicated by such forward-looking statements. Overview We were incorporated in 1999, but functioned as a development stage company with limited activities through December 2009. In January 2010, we acquired Digital Comm, Inc. ("Digital"), a provider of specialty contracting services primarily in the installation of fiber optic telephone cable. Until September 2012, substantially all of our revenue came from our specialty contracting services. In the years ended December 31, 2013 and 2012, primarily as a result of our acquisition of ADEX, approximately 35% and 38%, respectively, of our revenue was derived from specialty contracting services, with the remaining 65% and 62%, respectively, coming from our telecommunications staffing services. In 2013, we evaluated our reporting segments and determined that we operate in two reportable segments, specialty contracting services and telecommunication staffing services. The telecommunication staffing services segment is comprised of the Adex reporting unit and provides contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. Specialty contracting services revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. Our operating divisions have been aggregated into the two reporting segments due to their similar economic characteristics, products, production methods and distribution methods. The specialty contracting service segment includes our AW Solutions, TNS, Tropical and RM Engineering reporting units. Our revenue increased from $17.1 million for the year ended December 31, 2012 to $51.4 million for the year ended December 31, 2013. Our net loss attributable to common stockholders increased from $2.1 million for the year ended December 31, 2012 to $25.4 million for the year ended December 31, 2013. As of December 31, 2013, our stockholders' deficit was $1.7 million. A significant portion of our services are performed under master service agreements and other arrangements with customers that extend for periods of one or more years. We are currently party to numerous master service agreements, and typically have multiple agreements with each of our customers. Master service agreements generally contain customer-specified service requirements, such as discrete pricing for individual tasks. To the extent that such contracts specify exclusivity, there are often a number of exceptions, including the ability of the customer to issue work orders valued above a specified dollar amount to other service providers, perform work with the customer's own employees and use other service providers when jointly placing facilities with another utility. In most cases, a customer may terminate an agreement for convenience with written notice. The remainder of our services are provided pursuant to contracts for specific projects. Long-term contracts relate to specific projects with terms in excess of one year from the contract date. Short-term contracts for specific projects are generally of three to four months in duration. During 2013 and 2012, the majority of our revenue and expenses was generated by our acquired companies. Of the $51.4 million in total revenues in the year ended December 31, 2013, $45.5 million was generated by the companies we acquired in 2012 and 2013. In 2012, $11.7 million of the total $17.1 million in revenues was generated by companies acquired in 2012. Cost of revenues of the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $34.2 million of our $37.3 million cost of revenues during the year ended December 31, 2013. In 2012, $8.7 million of the total $12.0 million in cost of revenues was incurred by the companies we acquired in 2012. Gross profit generated by the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $11.3 million of our $14.1 million gross profit during the year ended December 31, 2013. Gross profit generated by the companies we acquired in 2012 was $3.0 million of the total gross profit of $5.1 million in 2012. Operating expenses, including salaries and wages and depreciation and amortization, for the companies we acquired in the years ended December 31, 2012 and 2013 accounted for $8.2 million of our $20.5 million of operating expenses during the year ended December 31, 2013. Operating expenses for the companies we acquired in 2012 was $1.9 million of the total $7.9 million of operating expenses during the year ended December 31, 2012. The following table summarizes our revenues from multi-year master service agreements and other long-term contracts, as a percentage of contract revenues: Year ended December 31, 2013 2012 Multi-year master service agreements and long-term contracts 65 % 60 % The percentage of revenue from long-term contracts varies between periods, depending on the mix of work performed under our contracts. A significant portion of our revenue comes from several large customers. The following table reflects the percentage of total revenue from those customers that contributed at least 10% to our total revenue in the years ended December 31, 2013 and 2012: Year ended December 31, 2013 2012 Ericsson, Inc. 41 % 33 % Nexlink 0 % 14 % We are a single-source provider of end-to-end IT and next-generation network solutions to the telecommunications service provider (carrier) and corporate enterprise markets through cloud platforms and professional services. We believe our market advantages center around our cloud-based applications and services portfolio and positioning. As a true infrastructure 2.0 provider, we add value by enabling applications and services while helping to contain costs. Customers now demand a partner that can provide end-to-end IT solutions, that offers a solution that allows the customer to move IT expenditures from capital costs to operating costs, and that offers the customer greater elasticity and the ability to rapidly deploy enterprise applications. Telecommunications providers and enterprise customers continue to seek and outsource solutions in order to reduce their investment in capital equipment, provide flexibility in workforce sizing and expand product offerings without large increases in incremental hiring. As a result, we believe there is significant opportunity to expand both our United States and international telecommunications solutions services and staffing services capabilities. As we continue to expand our presence in the marketplace, we will target those customers going through new network deployments and wireless service upgrades. 33 -------------------------------------------------------------------------------- We expect to continue to increase our gross margins by leveraging our single-source end-to-end network to efficiently provide a full spectrum of end-to-end IT and next-generation network solutions and staffing services to our customers. We believe our solutions and services offerings can alleviate some of the inefficiencies typically present in our industry, which result, in part, from the highly-fragmented nature of the telecommunications industry, limited access to skilled labor and the difficulty industry participants have in managing multiple specialty-service providers to address their needs. As a result, we believe we can provide superior service to our customers and eliminate certain redundancies and costs for them. We believe our ability to address a wide range of end-to-end solutions, network infrastructure and project-staffing service needs of our telecommunications industry clients is a key competitive advantage. Our ability to offer diverse technical capabilities (including design, engineering, construction, deployment, and installation and integration services) allows customers to turn to a single source for those specific specialty services, as well as to entrust us with the execution of entire turn-key solutions. As a result of our recent acquisitions, we have become a multi-faceted company with an international presence. We believe this platform will allow us to leverage our corporate and other fixed costs and capture gross margin benefits. Our platform is highly scalable. We typically hire workers to staff projects on a project-by-project basis and our other operating expenses are primarily fixed. Accordingly, we are generally able to deploy personnel to infrastructure projects in the United States and beyond without incremental increases in operating costs, allowing us to achieve greater margins. We believe this business model enables us to staff our business efficiently to meet changes in demand. Finally, given the worldwide popularity of telecommunications and wireless products and services, we will selectively pursue international expansion, which we believe represents a compelling opportunity for additional long-term growth. Our planned expansion will place increased demands on our operational, managerial, administrative and other resources. Managing our growth effectively will require us to continue to enhance our operations management systems, financial and management controls and information systems and to hire, train and retain skilled telecommunications personnel. The timing and amount of investments in our expansion could affect the comparability of our results of operations in future periods. Our recent and planned acquisitions have been and will be timed with additions to our management team of skilled professionals with deep industry knowledge and a strong track record of execution. Our senior management team brings an average of over 25 years of individual experience across a broad range of disciplines. We believe our senior management team is a key driver of our success and is well-positioned to execute our strategy. Factors Affecting Our Performance Changes in Demand for Data Capacity and Reliability. Advances in technology architectures have supported the rise of cloud computing, which enables the delivery of a wide variety of cloud-based services, such as platform as a service (PaaS), infrastructure as a service (IaaS), database as a service (DbaaS), and software as a service (SaaS). Today, mission-critical applications can be delivered reliably, securely and cost-effectively to our customers over the internet without the need to purchase supporting hardware, software or ongoing maintenance. The lower total cost of ownership, better functionality and flexibility of cloud applications represent a compelling alternative to traditional on-premise solutions. As a result, enterprises are increasingly adopting cloud services to rapidly deploy and integrate applications without building out their own expensive infrastructure and to minimize the growth of their own IT departments and create business agility by taking advantage of accelerated time-to-market dynamics. The telecommunications industry has undergone and continues to undergo significant changes due to advances in technology, increased competition as telephone and cable companies converge, the growing consumer demand for enhanced and bundled services and increased governmental broadband stimulus funding. As a result of these factors, the networks of our customers increasingly face demands for more capacity and greater reliability. Telecommunications providers continue to outsource a significant portion of their engineering, construction and maintenance requirements in order to reduce their investment in capital equipment, provide flexibility in workforce sizing, expand product offerings without large increases in incremental hiring and focus on those competencies they consider core to their business success. These factors drive customer demand for our services. The proliferation of smart phones and other wireless data devices has driven demand for mobile broadband. This demand and other advances in technology have prompted wireless carriers to upgrade their networks. Wireless carriers are actively increasing spending on their networks to respond to the explosion in wireless data traffic, upgrade network technologies to improve performance and efficiency and consolidate disparate technology platforms. These customer initiatives present long-term opportunities for us for the wireless services we provide. Further, the demand for mobile broadband has increased bandwidth requirements on the wired networks of our customers. As the demand for mobile broadband grows, the amount of cellular traffic that must be "backhauled" over customers' fiber and coaxial networks increases and, as a result, carriers are accelerating the deployment of fiber optic cables to cellular sites. These trends are increasing the demand for the types of services we provide. 34 --------------------------------------------------------------------------------Our Ability to Recruit, Manage and Retain High-Quality IT and Telecommunications Personnel. The shortage of skilled labor in the telecommunications industry and the difficulties in recruiting and retaining skilled personnel can frequently limit the ability of specialty contractors to bid for and complete certain contracts. In September 2012, we acquired ADEX, an IT and telecommunications staffing firm. Through ADEX, we manage a database of more than 70,000 IT and telecom personnel, which we use to locate and deploy skilled workers for projects. We believe our access to a skilled labor pool gives us a competitive edge over our competitors as we continue to expand. However, our ability to continue to take advantage of this labor pool will depend, in part, on our ability to successfully integrate ADEX into our business. Our Ability to Integrate Our Acquired Businesses and Expand Internationally. We completed six acquisitions since January 1, 2012 and plan to consummate additional acquisitions in the near term. Our success will depend, in part, on our ability to successfully integrate these businesses into our global IT and telecommunications platform. In addition, we believe international expansion represents a compelling opportunity for additional growth over the long-term because of the worldwide need for IT and telecommunications infrastructure. As of December 31, 2013, our operations in Puerto Rico have generated $4.1 million in revenue. We plan to expand our global presence either through expanding our current operations or by acquiring subsidiaries with international platforms. Our Ability to Expand and Diversify Our Customer Base. Our customers for specialty contracting services consist of leading telephone, wireless, cable television and data companies. Ericsson Inc. is our principal telecommunications staffing services customer. Historically, our revenue has been significantly concentrated in a small number of customers. Although we still operate at a net loss, our revenue in recent years has increased as we have acquired additional subsidiaries and diversified our customer base and revenue streams. The percentage of our revenue attributable to our top 10 customers, as well as key customers that contributed at least 10% of our revenue in at least one of the years specified in the following table, were as follows: Customer: Year ended December 31, 2013 2012 Top 10 customers, aggregate 74 % 77 % Customer: Nexlink * % 14 % Ericsson, Inc. 41 % 33 % _________________ * Represented less than 10% of total revenues during the period. Business Unit Transitions. In the year ended December 31, 2012, approximately 38% of our revenue came from our specialty contracting services, and the remaining 62% came from our telecommunications staffing services. In the year ended December 31, 2013, approximately 35% of our revenue came from specialty contracting services, and the remaining 65% come from our telecommunications staffing services. The acquisition of ADEX in 2012 enabled us to shift our business focus from exclusively providing specialty contracting services to also providing professional staffing services, which has expanded our customer base. Since January 1, 2012, we have acquired six other companies, and each of these acquisitions has either enhanced certain of our existing business units or allowed us to gain market share in new lines of business. For example, our acquisition of T N S in September 2012 extended the geographic reach of our structured cabling and digital antenna system services. Our acquisition of AW Solutions in April 2013 broadened our suite of services and added new customers to which we can cross-sell our other services. Our acquisition of IPC in January 2014 improved our systems integration capabilities. Our acquisition of RentVM in February 2014 expanded our cloud and managed services capabilities by providing us a software-defined data center ("SDDC") platform to offer enterprise-grade cloud computing solutions. Our proposed acquisition of VaultLogix will broaden our suite of cloud service offerings by adding VaultLogix's cloud backup services to our wide range of cloud offerings and will add new customers to which we can cross-sell our other services. Our proposed acquisition of Telco will further expand our professional staffing business and our access to skilled labor. 35-------------------------------------------------------------------------------- We expect these acquisitions to facilitate geographic diversification that should protect against regional cyclicality. We believe our diverse platform of services, capabilities, customers and geographies will enable us to grow as the market continues to evolve. The table below summarizes the revenues for each of our reportable segments for the years ended December 31, 2013 and 2012. Year ended December 31, 2013 2012 Revenue from: Specialty contracting services $ 18,224,317 $ 6,513,763 Telecommunications staffing services $ 33,183,227 $ 10,575,786 As a percentage of total revenue: Specialty contracting services 35 % 38 % Telecommunications staffing services 65 % 62 % Impact of Pending and Recently-Completed Acquisitions We have grown significantly and expanded our service offerings and geographic reach through a series of strategic acquisitions. Since January 1, 2012, we have completed six acquisitions. We expect to regularly review opportunities, and periodically to engage in discussions, regarding possible additional acquisitions. Our ability to sustain our growth and maintain our competitive position may be affected by our ability to identify, acquire and successfully integrate companies. We intend to operate all of the companies we acquire in a decentralized model in which the management of the companies will remain responsible for daily operations while our senior management will utilize their deep industry expertise and strategic contacts to develop and implement growth strategies and leverage top-line and operating synergies among the companies, as well as provide overall general and administrative functions. In November 2012, we executed a definitive agreement to acquire Telco, and in March 2014, we executed a definitive agreement to acquire VaultLogix. It is our intention is to complete the VaultLogix acquisition within 90 days of the date of this report, subject to our ability to raise the necessary cash proceeds to complete such acquisition. After the completion of the VaultLogix acquisition and reflecting the consolidation of the companies that we acquired in 2014 in our results of operations, we expect our revenues, cost of revenues and operating expenses will increase substantially. Accordingly, our future results of operations may differ significantly from those described in this report. The impact of our 2014 acquisitions and our pending acquisition of VaultLogix is not reflected in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section. We have not yet determined when we will consummate the acquisition of Telco, if at all. The Telco acquisition also is dependent on our ability to obtain satsifactory financing and there can be no assurance that such financing will be available to us. General Economic Conditions. Within the context of a slowly-growing economy and the current volatility in the credit and equity markets, we believe the latest trends and developments support our steady industry outlook. We will continue to closely monitor the effects that changes in economic and market conditions may have on our customers and our business and we will continue to manage those areas of the business we can control. Components of Results of Operations Revenue. In the year ended December 31, 2012, we derived approximately 38% of our revenue from our specialty contracting services and approximately 62% of our revenue from our telecommunications staffing and training services. In the year ended December 31, 2013, we derived approximately 35% of our revenue from our specialty contracting services and approximately 65% from our telecommunications staffing and training services. 36 --------------------------------------------------------------------------------Cost of Revenues. Cost of revenues includes all direct costs of providing services under our contracts, including costs for direct labor provided by employees, services by independent subcontractors, operation of capital equipment (excluding depreciation and amortization), direct materials, insurance claims and other direct costs. Cost of revenues in the year ended December 31, 2013 was 73% of revenues as compared to 70% of revenues in the year ended December 31, 2012, primarily due to lower margins in our telecommunications staffing business. Cost of revenues in the telecommunications staffing business was 79% and 78% of revenues in the years ended December 31, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues in the specialty contracting business was 60% and 57% of revenues in the years ended December 31, 2013 and 2012, respectively. We are trying to increase efficiency in the year ending December 31, 2014 and will focus our efforts on improving margins. We retain the risk of loss, up to certain limits, for claims related to automobile liability, general liability, workers' compensation, employee group health and location damages. We are sometimes subject to claims for damages resulting from property and other damages arising in connection with our specialty contracting services. A change in claims experience or actuarial assumptions related to these risks could materially affect our results of operations. For a majority of the contract services we perform, our customers provide all required materials while we provide the necessary personnel, tools and equipment. Materials supplied by our customers, for which the customer retains financial and performance risk, are not included in our revenue or costs of revenues. We expect cost of revenues to continue to increase if we succeed in continuing to grow our revenue. General and Administrative Costs. General and administrative costs include all of our corporate costs, as well as costs of our subsidiaries' management personnel and administrative overhead. These costs primarily consist of employee compensation and related expenses, including legal, consulting and professional fees, information technology and development costs, provision for or recoveries of bad debt expense and other costs that are not directly related to performance of our services under customer contracts. Our senior management, including the senior managers of our subsidiaries, perform substantially all of our sales and marketing functions as part of their management responsibilities and, accordingly, we have not incurred material sales and marketing expenses. Information technology and development costs included in general and administrative expenses are primarily incurred to support and to enhance our operating efficiency. We expect these expenses to continue to generally increase as we expand our operations, but expect that such expenses as a percentage of revenues will decrease if we succeed in increasing revenues. Goodwill and Indefintite Lived Intangible Assets Goodwill was generated through the acquisitions we made during 2011, 2012 and 2013. As the total consideration we paid for our completed acquisitions exceeded the value of the net assets acquired, we recorded goodwill for each of the completed acquisitions (see Note 3. Acquisitions and Deconsolidation of Subsidiary). At the date of acquisition, we performed a valuation to determine the value of the goodwill and intangible assets, along with the allocation of assets and liabilities acquired. The goodwill is attributable to synergies and economies of scale provided to we by the acquired entity. We perform our annual impairment test at the reportable segment level. The two reporting segments are telecommunication staffing services and specialty contracting services. Telecommunications staffing services is comprised of the ADEX entities, and specialty contracting services is comprised of TNS, Tropical, AW Solutions and RM Engineering. The components within the specialty contracting reportable segment are each considered individual reporting units. These reporting units are aggregated to form one operating segment and reportable segment for financial reporting and for the evaluation of goodwill for impairment. The telecommunications staffing reporting segment consists of one operating segment, which in turn consists of one reporting unit comprised of a single component. We perform the impairment testing at least annually (at December 31) or at other times if we believe that it is more likely than not that there may be an impairment to the carrying value of its goodwill. If it is more likely than not, that goodwill impairment exists, the second step of the goodwill impairment test should be performed to measure the amount of impairment loss, if any. We consider the results of an income approach and a market approach in determining the fair value of the reportable segments. We evaluated the forecasted revenue using a discounted cash flow model for each of the reporting segments. We also noted no unusual cost factors that would impact operations based on the nature of the working capital requirements of the components comprising the reportable segments. Current operating results, including any losses, are evaluated by us in the assessment of goodwill and other intangible assets. The estimates and assumptions used in assessing the fair value of the reporting units and the valuation of the underlying assets and liabilities are inherently subject to significant uncertainties. Key assumptions used in the income approach in evaluating goodwill are forecasts for each of the reporting units revenue growth rates along with forecasted discounted free cash flows for each reporting unit, aggregated into each reporting segment. For the market approach, we used the guideline public company method, under which the fair value of a business is estimated by comparing the subject company to similar companies with publicly traded ownership interests. From these "guideline" companies, valuation multiples are derived and then applied to the appropriate operating statistics of the subject company to arrive at indications of value. While we use available information to prepare estimates and to perform impairment evaluations, actual results could differ significantly from these estimates or related projections, resulting in impairment related to recorded goodwill balances. Additionally, adverse conditions in the economy and future volatility in the equity and credit markets could impact the valuation of our reporting units. We can provide no assurances that, if such conditions occur, they will not trigger impairments of goodwill and other intangible assets in future periods. Events that could cause the risk for impairment to increase are the loss of a major customer or group of customers, the loss of key personnel and changes to current legislation that may impact our industry or its customers' industries. However, based on our assessment of these factors, we believe the increase in the risk of impairment to be relatively low as our relationships with key customers and personnel are in good standing and we are unaware of any adverse legislation that may have a negative impact on us or our customers. Based on this review, we determined that there was no impairment as of December 31, 2013 and 2012, and as such, did not perform a step two analysis for impairment. With regard to other long-lived assets and intangible assets with indefinite-lives, we follow a similar impairment assessment. We will assess the quantitative factors to determine if an impairment test of the indefinite-lived intangible asset is necessary. If the quantitative assessment reveals that it is more likely than not that the asset is impaired, a calculation of the asset's fair value is made. Fair value is calculated using many factors, which include the future discounted cash flows as well as the estimated fair value of the asset in an arm's-length transaction. As of December 31, 2013 and 2012, the results of our analysis indicated that no impairment existed. 37 -------------------------------------------------------------------------------- We review finite-lived intangible assets for impairment whenever an event occurs or circumstances change that indicates that the carrying amount of such assets may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred. Fair Value of Embedded Derivatives. We used the Black-Scholes option-pricing model to determine the fair value of the derivative liability related to the warrants and the put and effective price of future equity offerings of equity-linked financial instruments. We derived the fair value of warrants using the common stock price, the exercise price of the warrants, risk-free interest rate, the historical volatility, and our dividend yield. We do not have sufficient historical data to use our historical volatility; therefore the expected volatility is based on the historical volatility of comparable companies. We developed scenarios to take into account estimated probabilities of future outcomes. The fair value of the warrant liabilities is classified as Level 3 within our fair value hierarchy. On August 6, 2010, we issued to UTA Capital LLC warrants to purchase 16% of our common stock on a fully-diluted basis, which were exercisable at $75.00 per share and provided for cashless exercise. Such warrants were cancelled in September 2012 in consideration of the issuance of 53,775 shares of our common stock. The relative fair value of such warrants was calculated using the Black-Scholes Option pricing model. This amount, totaling approximately $872,311, was recorded as a derivative liability and debt discount and charged to interest expense over the life of the related promissory note. The warrants issued to UTA Capital LLC did not meet the criteria to be classified as equity in accordance with ASC 815-40-15-7D and were classified as derivative liabilities at fair value and marked to market because they were not indexed to our stock as the settlement amount was not fixed due to the variability of the number of shares issuable pursuant to such warrants. The derivative liability associated with this debt was revalued each reporting period and the increase or decrease was recorded to our consolidated statement of operations under the caption "change in fair value of derivative instruments." On February 14, 2011, we entered into an extension and modification agreement with UTA Capital LLC in connection with our outstanding note payable to UTA Capital LLC, which had a balance of $775,000 at December 31, 2010. The modification agreement provided for an extension of the original maturity date of the note from August 6, 2011 to September 30, 2011. In exchange for consenting to the modification agreement, UTA Capital LLC was issued 10,257 shares of our common stock, which had a fair value of $153,850 and was recorded as a debt discount. Additionally, as additional consideration for our failure to satisfy a certain covenant in the agreement, UTA Capital LLC was issued 4,000 shares of our common stock, which shares were recorded as a penalty paid to the lender and recorded as an expense. These shares were issued in 2012. Pursuant to a Loan and Security Agreement dated as of September 17, 2012, as amended, among our company, our subsidiaries, as guarantors, the lenders party thereto and MidMarket Capital Partners, LLC, as agent, or the "MidMarket Loan Agreement," on September 17, 2012, we issued warrants to the lenders to purchase an aggregate of 1,105,920 shares of common stock based on the fully-diluted shares outstanding at that time. The warrants were amended on November 13, 2012 in connection with the first amendment to the MidMarket Loan Agreement to increase the aggregate number of shares issuable upon exercise of such warrants to 1,501,882 shares based on the fully-diluted shares outstanding at that time. Pursuant to the second amendment to the MidMarket Loan Agreement dated March 22, 2013, the aggregate number of shares of common stock issuable upon exercise of such warrants was set at 187,386 shares. Pursuant to the anti-dilution provisions of such warrants, upon the completion of the public offering of our common stock in November 2013, the number of shares of common stock issuable upon exercise of such warrants was reset to 234,233 shares. The warrants have an exercise price of $4.00 per share, subject to adjustment as set forth in the warrants, and will expire on September 17, 2014 provided certain Financial metrics have been met or on later dates until such financial metrics are met. The warrants have anti-dilution rights in connection with the exercise price. For financial reporting purposes, we have determined that the fair value of the anti-dilution rights is immaterial. If we issue stock, warrants or options at a price below the $4.00 per share exercise price, the price of the warrants resets to the lower price. As of December 31, 2013, the lenders had not exercised the warrants. These warrants meet the criteria in ASC 480 to be classified as liabilities because there is a put feature pursuant to which we have an obligation to repurchase such warrants. The derivative liability associated with this debt will be revalued each reporting period and the increase or decrease in value will be recorded to the consolidated statement of operations under the caption "change in fair value of derivative instruments." 38 -------------------------------------------------------------------------------- On September 17, 2012, when the warrants were issued, we recorded a derivative liability in the amount of $193,944. The amount was recorded as a debt discount and is being amortized over the life of the loan. The amount of the derivative liability was computed by using the Black-Scholes Option pricing model to determine the value of the warrants issued. At December 31, 2013 and 2012, the remaining debt discount was $143,843 and $182,631, respectively. The fair value of the MidMarket warrant derivative at each measurement date was calculated using the Black-Scholes option pricing model with the following factors, assumptions and methodologies: December 31, December 31, 2013 2012 Fair value of our common stock $ 18.36 $ 0.68755-10.00 Volatility 80 % 56.78-112 % Exercise price $ 4.00 to $5.00 $ .95 to $500.00 Estimated life 8.5 months 1.75 years Risk free interest rate (based on 1 year treasury rate) 0.11 % 0.0266-0.12 % We issued warrants to ICG USA, LLC and Venture Champion Asia Limited in connection with loans we received from those entities in April, August and October 2013. On April 30, 2013, August 28, 2013 and October 30, 2013, the dates on which the warrants were issued, we recorded derivative liabilities in the amount of $140,000, $35,000 and $19,000, respectively. Those amounts were recorded as a debt discount and are being amortized over the life of the related loans. The amount of the derivative liability was computed by using the binomial method to determine the value of the warrants issued. In applying the binomial method, we evaluated possible scenarios for the price of our common stock and other factors that would impact the anti-dilution provisions of the warrants. In December 2013, we entered into a securities purchase agreement with various institutional investors pursuant to which we issued to such investors the Convertible Debentures in the original aggregate principal amount of $11,625,000 and an aggregate of 36,567 shares of our common stock for an aggregate purchase amount of $11,625,002. The Convertible Debentures mature on June 13, 2015 and bear interest at the rate of 12% per annum and are payable in accordance with an amortization schedule. The Convertible Debentures are convertible into shares of our common stock at the election of the holder thereof at a conversion price equal to the lesser of (i) $6.36, or (ii) 85% of the price per share of our common stock in the first underwritten public offering we complete of not less than $10 million of our equity securities (a "Qualified Offering"). The conversion price is subject to customary anti-dilution provisions. On the date of issuance of the Convertible Debentures, we recorded a derivative liability in the amount of $6,620,000 in connection with the embedded features of the Convertible Debentures, which was recorded as a debt discount and is being amortized over the life of the Convertible Debentures. The amount of the derivative liability was calculated using the binomial method. The fair value of the embedded derivatives of the Convertible Debentures at the measurement date was calculated using a Monte Carlo model using the following factors, assumptions and methodologies: December 31, 2013 Conversion price $ 6.36 Conversion trigger price $ 15.90 Risk free rate 0.3 % Life of conversion feature (in years) 1.5 Volatility 60 % The fair value of the embedded derivatives of the Convertible Debenture at December 31, 2013 was calculated using a Monte Carlo model using the same factors, assumptions and methodologies as at the initial measurement date, with the exception of the life of the conversion feature which was changed to 1.45 years. The aggregate fair value of our derivative liabilities as of December 31, 2013 and 2012 amounted to $19.9 million and $33,593, respectively. 39 --------------------------------------------------------------------------------Income Taxes. In the year ended December 31, 2013, we booked a provision for state and local income taxes due of $90,459. Certain states do not recognize net operating loss carryforwards, and we have operations in some of those states. The provision for state and local income taxes was offset by an increase in deferred tax liabilities of $1,982,147. This tax benefit was a result of our acquisition of ADEX and T N S in 2012, which resulted in a deferred tax liability based on the value of the intangible assets acquired. This benefit was offset by the fact that ADEX and T N S were cash-basis taxpayers when they were acquired and were converted to accrual-basis taxpayers upon acquisition, which resulted in an increase in liability. As of December 31, 2013 and 2012, we had net operating loss carryforwards (NOLs) of $4.3 million and $2.1 million, respectively, which will be available to reduce future taxable income and expense through 2030. Utilization of the net operating loss and credit carryforwards is subject to an annual limitation due to the ownership percentage change limitations provided by Section 382 of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization. We have adjusted our deferred tax asset to record the expected impact of the limitations. Credit Risk. We are subject to concentrations of credit risk relating primarily to our cash and equivalents, accounts receivable, other receivables and costs and estimated earnings in excess of billings. Cash and equivalents primarily include balances on deposit in banks. We maintain substantially all of our cash and equivalents at financial institutions we believe to be of high credit quality. To date, we have not experienced any loss or lack of access to cash in our operating accounts. We grant credit under normal payment terms, generally without collateral, to our customers. These customers primarily consist of telephone companies, cable broadband MSOs and electric and gas utilities. With respect to a portion of the services provided to these customers, we have certain statutory lien rights that may, in certain circumstances, enhance our collection efforts. Adverse changes in overall business and economic factors may impact our customers and increase potential credit risks. These risks may be heightened as a result of economic uncertainty and market volatility. In the past, some of our customers have experienced significant financial difficulties and, likewise, some may experience financial difficulties in the future. These difficulties expose us to increased risks related to the collectability of amounts due for services performed. We believe that none of our significant customers were experiencing financial difficulties that would materially impact the collectability of our trade accounts receivable as of December 31, 2013. Contingent Consideration. We recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree or assets of the acquiree in a business combination. The contingent consideration is classified as either a liability or equity in accordance with ASC 480-10 ("Accounting for certain financial instruments with characteristics of both liabilities and equity"). If classified as a liability, the liability is remeasured to fair value at each subsequent reporting date until the contingency is resolved. Increases in fair value are recorded as losses on our consolidated statement of operations, while decreases are recorded as gains. If classified as equity, contingent consideration is not remeasured and subsequent settlement is accounted for within equity. Litigation and Contingencies. Litigation and contingencies are reflected in our consolidated financial statements based on management's assessment of the expected outcome of such litigation or expected resolution of such contingency. An accrual is made when the loss of such contingency is probable and reasonably estimable. If the final outcome of such litigation and contingencies differs significantly from our current expectations, such outcome could result in a charge to earnings. 40 --------------------------------------------------------------------------------Results of Operations The following table shows our results of operations for the year indicated. The historical results presented below are not necessarily indicative off the results that may be expected for any future period. Year ended December 31, 2013 2012 Statement of Operations Data: Revenues $ 51,407,544 $ 17,089,549 Cost of revenue 37,280,044 11,968,215 Gross profit 14,127,500 5,121,334 Operating expenses: Depreciation and amortization 1,120,404 345,566 Salaries and wages 8,341,011 3,802,158 General and administrative 7,875,723 3,782,067 Change in fair value and loss on contingent consideration 3,131,130 - Total operating expenses 20,468,268 7,929,791 Loss from operations (6,340,768 ) (2,808,457 ) Total other expense (19,074,751 ) (1,097,863 ) Loss from continuing operations before (benefit from) income taxes (25,415,519 ) (3,906,320 ) Benefit from income taxes (587,662 ) (2,646,523 ) Net loss from continuing operations (24,827,857 ) (1,259,797 ) Income from discontinued operations including gain on sale of subsidiary, net of tax 549,922 46,598 Net loss (24,277,935 ) (1,213,199 ) Net loss attributable to non-controlling interest 76,169 16,448 Net loss attributable to InterCloud Systems, Inc. (24,354,104 ) (1,229,647 ) Less dividends on Series C, D, E, F and H Preferred Stock (1,084,314 ) (843,215 ) Net loss attributable to InterCloud Systems, Inc. common stockholders $ (25,438,418 ) $ (2,072,862 ) Year ended December 31, 2013 compared to year ended December 31, 2012 Revenue. Year ended December 31, Change 2013 2012 Dollars Percentage Specialty contracting services $ 18,224,317 $ 6,513,763 $ 11,710,554 180 % Telecommunication staffing services 33,183,227 10,575,786 22,607,441 214 % Total $ 51,407,544 $ 17,089,549 $ 34,317,995 201 % Total revenue for the year ended December 31, 2013 was $51.4 million, which represented an increase of $34.3 million, or 201%, compared to total revenue of $17.1 million for the year ended December 31, 2012. The increase in total revenue during this period was attributed to revenue generated by our acquired companies. For the year ended December 31, 2012, 38% of our revenue was derived from our specialty contracting services and 62% of our revenue was derived from our telecommunications staffing services. For the year ended December 31, 2013, 35% of our revenue was derived from our specialty contracting services and 65% of our revenue was derived from our telecommunications staffing services. In the years ended December 31, 2013 and 2012, $45.5 million and $11.7 million, respectively, of our revenues were generated by the companies we acquired. During the years ended December 31, 2013 and 2012, all of the revenue in the telecommunication staffing services segment came from the companies we acquired in 2012, while revenues in the specialty contracting services segment from the companies we acquired in 2012 and 2013 amounted to $12.3 million and $1.0 million in the years ended December 31, 2013 and 2012, respectively. 41 --------------------------------------------------------------------------------Cost of revenue and gross margin. Year ended December 31, Change Specialty contracting services 2013 2012 Dollars Percentage Cost of revenue $ 10,970,680 $ 3,727,588 $ 7,243,092 194 % Gross margin $ 7,253,637 $ 2,784,764 $ 4,468,873 160 % Gross profit percentage 40 % 43 % Telecommunication staffing services Cost of revenue $ 26,309,364 $ 8,240,627 $ 18,068,737 219 % Gross margin $ 6,873,864 $ 2,336,570 $ 4,537,294 194 % Gross profit percentage 21 % 22 % Total Cost of revenue $ 37,280,044 $ 11,968,215 $ 25,311,829 211 % Gross margin $ 14,127,501 $ 5,121,334 $ 9,006,167 176 % Gross profit percentage 27 % 30 % Our cost of revenue increased $25.3 million from $12.0 million for the year ended December 31, 2012 to $37.3 million for the year ended December 31, 2013. This increase was primarily due to the acquisitions completed in the years ended December 31, 2013 and 2012. For the year ended December 31, 2012, we had a revenue mix of 38% specialty contracting services as compared to telecommunications staffing services of 62%. For the year ended December 31, 2013, we had a revenue mix of 35% specialty contracting services as compared to telecommunications staffing services of 65%. Our gross profit percentage was 27% for the year ended December 31, 2013 compared to 30% for the year ended December 31, 2012. The decrease in gross margin was primarily a result of the increase in revenues in our telecommunications staffing services segment. The gross profit on our telecommunications staffing services segment were only 21%, which decreased the overall gross profit. It is expected that as the telecommunications staffing services portion of our total revenue increases, our overall gross profit percentage will continue to decline, while the gross profit dollars will increase. We expect to continue to see lower gross margins until such time as we generate a greater amount of revenue from services that generate higher margins than our telecommunications staffing services segment. General and Administrative. Year ended December 31, Change 2013 2012 Dollars Percentage General and administrative $ 7,875,723 $ 3,782,067 $ 4,093,656 108 % Percentage of revenue 15 % 22 % Our general and administrative expenses increased $4.1 million, from $3.8 million for the year ended December 31, 2012 to $7.9 million for the year ended December 31, 2013. General and administrative expenses related to our specialty contracting segment increased by $0.4 million, or 34%, during the year ended December 31, 2013. General and administrative expenses relating to our telecommunications staffing segment increased by $1.5 million, or 318%, during the year ended December 31, 2013. General and administrative expenses incurred on behalf of our corporate center increased by $2.2 million, or 108%, during the year ended December 31, 2013. The increases were primarily as a result of increased overhead expenses resulting from the acquisitions we completed in the years ended December 31, 2013 and 2012. General and administrative expenses decreased to 15% of revenues in the year ended December 31, 2013, from 22% in the year ended December 31, 2012. This decrease in percentage was a result of the increased revenues, which did not cause a corresponding increase in general and administrative expenses. Salaries and Wages. Year ended December 31, Change 2013 2012 Dollars Percentage Salaries and wages $ 8,341,011 $ 3,802,158 $ 4,538,853 119 % Percentage of revenue 16 % 22 % Our salaries and wages increased $4.5 million from $3.8 million for the year ended December 31, 2012 to $8.3 million for the year ended December 31, 2013. Salaries and wages expenses related to our specialty contracting segment increased by $0.4 million, or 20%, during the year ended December 31, 2013. Salaries and wages expenses relating to our telecommunications staffing segment increased by $2.5 million, or 277%, during the year ended December 31, 2013. Salaries and wages expenses incurred on behalf of our corporate center increased by $1.6 million, or 171%, during the year ended December 31, 2013. The increases were primarily a result of an increase in the amount of stock compensation issued in 2013, as compared to 2012. Stock compensation increased from $0.8 million in the year ended December 31, 2012 to $3.4 million in the year ended December 31, 2013. The increase also results from an increase in the amount of employees during 2013 due to the acquisitions in late 2012 and in 2013. Depreciation and Amortization. Year ended December 31, Change 2013 2012 Dollars Percentage Depreciation and amortization $ 1,120,404 $ 345,566 $ 774,838 224 % Percentage of revenue 2 % 2 % Depreciation and amortization expenses increased by approximately $0.8 million to $1.1 million in the year ended December 31, 2013, as compared to $0.3 million in the year ended December 31, 2012. Depreciation and amortization expenses related to our specialty contracting segment increased by $0.5 million, or 239%, during the year ended December 31, 2013. Our depreciation and amortization expenses relating to our telecommunications staffing segment increased by $0.2 million, or 200%, during the year ended December 31, 2013. Depreciation and amortization expenses incurred on behalf of our corporate center increased by $0.1 million, or 97%, during the year ended December 31, 2013. The increases were a result of the acquisitions completed in 2013 and 2012. 42 --------------------------------------------------------------------------------Changes in Fair Value of Derivative Liabilities. The aggregate fair value of derivative liabilities as of December 31, 2013 and December 31, 2012 amounted to approximately $19.9 million and $0.03 million, respectively. As a result of the change in the fair value of our derivative instruments, we recorded a loss of $14.2 million and a gain of $0.2 million in the years ended December 31, 2013 and 2012, respectively. The loss in the year ended December 31, 2013 was primarily a result of the increases in the fair value of our common stock, which increased the fair value of the derivative instruments. Net Gain on Deconsolidation of Subsidiary. During 2012, we sold 60% of the outstanding shares of common stock of Digital Comm, Inc. ("Digital"). In connection with such sale, we recognized a gain on deconsolidation of $0.5 million, based on the negative investment carrying amount. We made additional investments in Digital of approximately $0.2 million during 2012, at which time we wrote off the remaining balance of our investment in Digital. The result for the year was a net gain of $0.5 million on the deconsolidation of Digital. Net gain on Discontinued Operations. During 2013, we sold our 100% membership interest in Environmental Remediation and Financial Services, LLC. In connection with such sale, we recognized a gain on discontinued operations of $0.2 million. Interest Expense. Year ended December 31, Change 2013 2012 Dollars Percentage Interest expense $ 5,574,228 $ 1,699,746 $ 3,874,482 228 % Interest expense increased $3.9 million from $1.7 million in the year ended December 31, 2012 to $5.6 million for the year ended December 31, 2013, primarily due to increases in our outstanding debt obligations. Included in interest expense is the amortization of debt discount and deferred loan costs. In the year ended December 31, 2013, amortization was $1.4 million compared to $0.4 million for the year ended December 31, 2012. Net Loss Attributable to our Common Stockholders. Net loss attributable to our common stockholders was $25.4 million for the year ended December 31, 2013, as compared to $2.1 million for the year ended December 31, 2012. Operating Income (Loss). Year ended December 31, Change 2013 2012 Dollars Percentage Specialty contracting services $ 2,427,369 $ (699,459 ) $ 3,126,828 447 % Telecommunication staffing services 1,069,808 820,375 249,433 30 % Corporate (9,837,945 ) (2,929,373 ) (6,908,572 ) 236 % Total $ (6,340,768 ) $ (2,808,457 ) $ (3,532,311 ) 126 % Operating loss increased $3.5 million from $2.8 million in the year ended December 31, 2012 to $6.3 million for the year ended December 31, 2013, primarily due to increases in our stock compensation expense, professional service changes and costs attributable to being a public company. Liquidity, Capital Resources and Cash Flows We have satisfied our capital and liquidity needs primarily through sales of equity securities, debt offerings and bank borrowings. As of December 31, 2013, we had cash of $17.9 million, which was exclusively denominated in U.S. dollars and consisted of bank deposits. As of December 31, 2013, none of our cash was held by foreign subsidiaries. Indebtedness. MidMarket Loan Agreement. On September 17, 2012, we entered into the MidMarket Loan Agreement, pursuant to which the lenders thereunder provided us with senior secured first lien term loans in an aggregate principal amount of $13,000,000. We used a portion of the proceeds of such loans to finance our recent acquisitions, to repay certain outstanding indebtedness and to pay related fees, costs and expenses. On November 13, 2012, we entered into a first amendment to the MidMarket Loan Agreement, pursuant to which the lenders provided us with additional senior secured first lien term loans in an aggregate principal amount of $2,000,000 and made certain other amendments to the MidMarket Loan Agreement. At December 31, 2013 and 2012, loans in the principal amount of $13.9 million and $15.0 million, respectively, were outstanding under the MidMarket Loan Agreement. In March 2014, the lenders under the MidMarket Loan Agreement assigned the loans under such agreement to certain institutional investors that subsequently converted the principal amount of such loans into an aggregate of 1,180,361 shares of our common stock at a conversion price of $10.50 per share. However, if 85% of the volume weighted average price of our common stock on April 14, 2014 is less than $10.50, we are obligated to issue to such institutional investors additional shares of common stock so that the average conversion price of the loans under the MidMarket Loan Agreement is such lower price. At the time of such conversion, all accrued interest on such loans was paid in full in cash. 43-------------------------------------------------------------------------------- Pursuant to the MidMarket Loan Agreement, we issued to the lenders warrants to purchase 187,386 shares of common stock at an initial exercise price of $5.00 per share, subject to adjustment as set forth in the warrants, on or before September 17, 2014, subject to extension if certain of our financial statements have not been delivered to the holders of such warrants in a timely manner showing that certain financial thresholds have been met. Upon the completion of a public offering of our common stock in November 2013, the number of shares of common stock issuable upon exercise of such warrants was increased to 234,233 shares and the exercise price of such warrants was reduced to $4.00 per share. PNC Bank Revolving Credit Facility. On September 20, 2013, we entered into the PNC Credit Agreement with PNC Bank, as agent and a lender, and each of our subsidiaries, as borrowers or guarantors. The PNC Credit Agreement provided us a revolving credit facility in the principal amount of up to $10,000,000, subject to certain borrowing base and other restrictions, that was secured by substantially all of our assets and the assets of our subsidiaries, including a pledge of the equity interests of our subsidiaries pursuant to a pledge agreement. The maturity date of the revolving credit facility was June 17, 2014, subject to certain extensions. Interest on advances under the revolving credit facility was payable in arrears on the first day of each month with respect to Domestic Rate Loans (as defined in the PNC Credit Agreement) and at the end of each interest period, with respect to LIBOR Rate Loans (as defined in the PNC Credit Agreement). Interest charges were computed on the greater of (x) $5,000,000 or (y) the actual principal amount of advances outstanding during the month at a rate per annum equal to, (i) in the case of Domestic Rate Loans, an interest rate per annum equal to the sum of the Alternate Base Rate (as defined in the PNC Credit Agreement) plus 0.50% per annum, or (ii) in the case of LIBOR Rate Loans, the LIBOR rate plus 2.75% per annum. Prior to each advance, we had the option of making such advance a Domestic Rate Loan or a LIBOR Rate Loan. The loans were subject to a borrowing base equal to the sum of (a) 88% of our eligible accounts receivable, plus (b) the lesser of (i) 65% of our Eligible Milestone Receivables (as defined in the PNC Credit Agreement) and (ii) $500,000, minus (c) the aggregate maximum undrawn amount of all outstanding letters of credit under the revolving credit facility, and minus (d) $2,500,000 (prior to the release of the availability block). Initially, the borrowing base was reduced by a $2,500,000 availability block that could have been be eliminated on September 30, 2014 if we were to meet certain financial conditions and were not in default under the revolving credit facility. As of December 31, 2013, we had borrowing availability under the PNC Credit Agreement of $1.5 million, and had a prepaid loan balance of $0.1 million. However, as of December 31, 2013, we were not in compliance with all of the covenants of the PNC Credit Agreement. We terminated the PNC Credit Agreement on April 4, 2014 and, pursuant to the terms of the PNC Credit Agreement, we incurred a termination charge of approximately $300,000 in connection with such termination. 44-------------------------------------------------------------------------------- 12% Convertible Debentures. On December 13, 2013, we entered into a securities purchase agreement with certain institutional investors pursuant to which we issued to such investors the Convertible Debentures in an original aggregate principal amount of $11,625,000 and an aggregate of 36,567 shares of our common stock. In connection with the issuance of the Convertible Debentures, we paid a fee to Aegis Capital of $989,000, resulting in net proceeds to us of $10,636,002. The Convertible Debentures bear interest at the rate of 12% per annum, and are payable in accordance with an amortization schedule, with monthly payments beginning on July 13, 2014 and ending on the final maturity date of June 13, 2015. At our election, subject to compliance with certain terms and conditions in the purchase agreement, the monthly amortization payments may be paid by the issuance of shares of our common stock at a price per share equal to the lesser of (i) the conversion price of the Convertible Debentures at that time and (ii) 75% of the average of the daily volume weighted average price, or VWAP, of our common stock for the five-trading-day period ending on, and including, the trading day immediately preceding the trading day that is five days prior to the applicable monthly amortization date. The Convertible Debentures are convertible into shares of our common stock at the election of the holder thereof at a conversion price equal to the lesser of (i) $6.36, or (ii) 85% of the price per share of our common stock in our next underwritten public offering of not less than $10 million of our equity securities, subject in each case to customary anti-dilution provisions. Notwithstanding the foregoing, the Convertible Debentures held a particular holder will not be convertible if such conversion would result in such holder owning more than 4.99% of the issued and outstanding shares of our common stock after such conversion. Beginning on June 13, 2014, we may elect to force the holder of a Convertible Debenture to convert all, but not less than all, amounts outstanding under such Convertible Debenture into shares of our common stock at the applicable conversion price; provided, that we may only elect such forced conversion if certain conditions are met, including the condition that our common stock has been trading at 150% or higher of the applicable conversion price for 30 consecutive trading days with an average daily trading volume of not less than $1,000,000 of shares per day. We may redeem a Convertible Debenture, in whole or in part, for cash at a redemption price, or the Redemption Amount, equal to 115% of the outstanding principal amount of the Convertible Debenture, plus all accrued and unpaid interest, plus an amount equal to the interest that would have accrued on such Convertible Debenture through December 13, 2014. If we complete an underwritten public offering of at least $10 million of our equity securities while the Convertible Debentures remain outstanding, (i) each holder of a Convertible Debenture has the option to force the redemption of a portion of such holder's Convertible Debentures for a redemption price equal to the Qualified Offering Amount (as defined below), and (ii) we have the option to force the redemption of each holder's Convertible Debentures in an amount equal to or less than the Qualified Offering Amount. The "Qualified Offering Amount means, with respect to each Convertible Debenture, an amount equal to the lesser of (i) 50% of the Redemption Amount and (ii) (a) 50% of the gross proceeds we receive in such public offering of equity securities multiplied by (b)(x) the Redemption Amount of such Convertible Debenture, divided by (y) the Redemption Amount of all Convertible Debentures issued pursuant to the Convertible Debenture purchase agreement. 45-------------------------------------------------------------------------------- Upon the acceleration of a Convertible Debenture following an event of default, as defined in the Convertible Debentures, the Mandatory Default Amount (as defined below) of such Convertible Debenture shall become due and payable in cash. The "Mandatory Default Amount" means the sum of (a) the greater of (i) the outstanding principal amount of such Convertible Debenture, plus all accrued and unpaid interest thereon, plus all interest that would have been earned thereon through December 13, 2014 if such interest has not yet accrued, divided by the lower of (A) the conversion price of the Convertible Debentures on the date the Mandatory Default Amount is demanded (if demand or notice is required to create an event of default) or otherwise due or (B) the conversion price of the Convertible Debentures on the date the Mandatory Default Amount is paid in full, multiplied by the higher of (x) the VWAP of our common stock on the date the Mandatory Default Amount is demanded or otherwise due or (y) the VWAP of our common stock on the date the Mandatory Default Amount is paid in full, or (ii) 115% of the outstanding principal amount of the Debenture, plus 100% of accrued and unpaid interest hereon, plus all interest that would have been earned through December 13, 2014 if such interest has not yet accrued, and (b) all other amounts, costs, expenses and liquidated damages due in respect of such Convertible Debenture. After the occurrence of an event of default that results in the acceleration of the Convertible Debentures, the interest rate on the Convertible Debentures will accrue at an interest rate equal to the lesser of 18% per annum or the maximum rate permitted under applicable law. Additionally, upon the occurrence of an event of default, at the holder's election each Convertible Debenture will become convertible into shares of our common stock at the lesser of (i) the conversion price of the Convertible Debentures, and (ii) 70% of the average VWAP of our common stock for the five trading days in the preceding twenty trading days that have the lowest VWAP during such period. Related Party Promissory Notes. On July 5, 2011, we entered into a definitive master funding agreement with MMD Genesis LLC ("MMD Genesis"), a company the three principals of which are our Chairman of the Board and Chief Executive Officer, Mark Munro, one of our directors, Mark F. Durfee, and Douglas Shooker, the principal of Forward Investments LLC, the beneficial owner of more than 5% of our common stock. Pursuant to the master funding agreement, MMD Genesis made loans to us from time to time to fund certain of our working capital requirements and a portion of the cash purchase prices of our business acquisitions. All such loans originally bore interest at the rate of 2.5% per month and matured on June 30, 2014. At December 31, 2013 and 2012, outstanding loans from MMD Genesis in the aggregate principal amount of $3,925,000 and $350,000, respectively, were outstanding. On January 1, 2014, the outstanding principal amount of the loans from MMD Genesis in the amount of $3,925,000, and accrued interest thereon in the amount of $963,746, was restructured and, in lieu thereof, we issued to the principals of MMD Genesis LLC or their designees the following notes: · a note issued to Mark Munro 1996 Charitable Remainder UniTrust in the principal amount of $275,000 that bears interest at the rate of 12% per annum and matures on March 31, 2016; · a note issued to CamaPlan FBO Mark Munro IRA in the principal amount of $346,904 that bears interest at the rate of 12% per annum and matures on March 31, 2016; · a note issued to 1112 Third Avenue Corp., a company controlled by Mark Munro, in the principal amount of $375,000 that bears interest at the rate of 12% per annum and matures on March 31, 2016; · a note issued to Mark Munro in the principal amount of $737,000 that bears interest at the rate of 12% per annum and matures on March 31, 2016; · a note issued to Pascack Road, LLC, a company controlled by Mark Durfee, in the principal amount of $1,575,000 that bears interest at the rate of 12% per annum and matures on March 31, 2016; · a note issued to Forward Investments, LLC in the principal amount of $650,000 that bears interest at the rate of 10% per annum, matures on June 30, 2015 and is convertible into shares of our common stock at an initial conversion price of $6.36 per share; and · a note issued to Forward Investments, LLC in the principal amount of $2,825,000 that bears interest at the rate of 2% per annum, matures on June 30, 2015 and is convertible into shares of our common stock at an initial conversion price of $6.36 per share. On February 4, 2014 and March 28, 2014, Forward Investments, LLC made loans to us for working capital purposes in the amounts of $1.8 million and $1.2 million, respectively. Such loans are evidenced by promissory notes that bear interest at the rate of 10% per annum, mature on June 30, 2015 and are convertible into shares of our common stock at an initial conversion price of $6.36 per share. ICG Convertible Promissory Notes. On April 26, 2013, we entered into a purchase agreement, or the ICG Purchase Agreement, with ICG USA, LLC, or ICG, pursuant to which we agreed to sell, and ICG agreed to purchase, unsecured convertible promissory notes, or the ICG Notes, in the aggregate principal amount of up to $1,725,000, for an aggregate purchase price of up to $1,500,000, at up to three separate closings, with each such closing subject to customary closing conditions. We received aggregate proceeds under the ICG Purchase Agreement of $1,500,000, with the difference between the amount of proceeds we received and the aggregate principal amount of the ICG Notes we issued representing an up-front interest payment, with no additional interest being owed on the ICG Notes. On April 30, 2013, at the first closing of the sale of ICG Notes under the ICG Purchase Agreement, we issued to ICG an ICG Note in the principal amount of $862,500 for a purchase price of $750,000, representing an up-front interest charge of $112,500. On August 28, 2013, at the second closing of the sale of ICG Notes under the ICG Purchase Agreement, we issued to ICG an ICG Note in the principal amount of $287,500 for a purchase price of $250,000, representing an up-front interest charge of $37,500. On October 30, 2013, at the third closing of the sale of ICG Notes under the ICG Purchase Agreement, we issued to ICG an ICG Note in the principal amount of $575,000 for a purchase price of $500,000, representing an up-front interest charge of $75,000. The initial ICG Note in the principal amount of $862,500 matured on the earlier of (i) the six-month anniversary of the original date of issuance of such ICG Note, or (ii) ten trading days after the consummation of any capital raise resulting in gross proceeds of at least $3,000,000. The ICG Note in the principal amount of $287,500 matured on the earlier of (i) the six-month anniversary of the original date of issuance of such ICG Note, or (ii) 90 trading days of after the consummation of any public offering resulting in gross proceeds of at least $3,000,000. If, however, we did not complete a capital raise by the six-month anniversary of the original date of issuance of either such ICG Note, then ICG could have elected to be repaid the principal amount of such ICG Note by either (a) receiving 25% of our future monthly cash flows until such time as all principal due under such ICG Note has been repaid and/or (b) converting the unpaid principal amount of such ICG Note into shares of our common stock. If, following such six-month period, ICG made such election to convert, the outstanding principle balance of the ICG Notes was convertible into shares of common stock at a price per share equal to 80% of the lesser of (i) the average of the closing bid prices of the common stock for each of the ten trading days preceding the date of conversation or (ii) the closing bid price of our common stock on the date of conversion, but in no event less than $11.60 per share. 46-------------------------------------------------------------------------------- At December 31, 2013, the aggregate outstanding principal amount of the three ICG Notes was $1,725,000. On March 4, 2014, the entire principal amount of the three ICG Notes was converted into 161,215 shares of our common stock. Pursuant to the ICG Purchase Agreement, in connection with the issuance of each ICG Note, we also issued to ICG two-year warrants, or the ICG Warrants, to purchase a number of shares of common stock equal to fifty percent (50%) of the number of shares into which the related ICG Note may be converted on the date of issuance of such ICG Note. The ICG Warrants were exercisable at an exercise price of 4.80 per share. In November 2013, ICG exercised all of the warrants on a cashless basis and received 138,396 shares of common stock. At the initial closing under the ICG Purchase Agreement, we paid to Aegis Capital Corp., the representative of the underwriters in our November 2013 equity offering, a placement agent fee in the amount of $69,000 for its services as placement agent for the securities sold at such closing. At the second closing under the ICG Purchase Agreement, we paid to Aegis Capital Corp. a placement agent fee in the amount of $23,000 for its services as placement agent for the securities sold at such closing. At the third closing under the ICG Purchase Agreement, we paid to Aegis Capital Corp. a placement agent fee of $34,750 for its services as placement agent for the securities sold at such closing. Wellington Promissory Note. On September 17, 2012, we entered into a promissory note, or the Wellington Note, with Wellington Shields & Co. LLC, or Wellington, as evidence of the fees we owed to Wellington for services rendered relating to the MidMarket Loan Agreement. The Wellington Note was for a term of 35 days with interest in arrears from September 17, 2012 at the lowest applicable federal rate of interest. As of December 31, 2012, $95,000 of principal plus accrued interest remained outstanding on the Wellington Note and we were in default due to our failure to pay such amounts in full. The Wellington Note was paid in full in May 2013. Note and Warrant Purchase Agreement with UTA Capital LLC. On August 6, 2010, we secured a working capital loan from UTA Capital LLC, with Digital Comm as the borrower. In connection with such loan, we issued to UTA Capital, LLC warrants initially to purchase 41,905 shares of our common stock with an exercise price of $75.00 per share. The warrants were exchanged for 52,190 shares of common stock on September 6, 2012. We paid off the remaining outstanding balance of this loan in September 2012. Obligations Under Purchase Agreements for Recent Acquisitions In connection with the acquisitions of our subsidiaries, we entered into purchase agreements pursuant to which we agreed to certain on-going financial and other obligations. The following is a summary of the material terms of the purchase agreements for our recent and pending acquisitions for which we have on-going financial obligations. T N S, Inc. On September 17, 2012, we entered into a Stock Purchase Agreement (the "T N S Agreement") with the stockholders of T N S pursuant to which we acquired all the outstanding capital stock of T N S for the following consideration paid or issued by us at the closing: (i) cash in the amount of $700,000, (ii) 4,150 shares of our Series F Preferred Stock, of which 575 shares are contingent and are subject to cancellation in whole or in part if T N S does not meet certain operating results for the year ending September 30, 2013, and (iii) 10,000 shares of our common stock. In addition, in the T N S Agreement, we agreed that, upon completion of this offering, we will issue to the sellers an aggregate number of shares of common stock equal to (i) $200,000 divided by (ii) the offering price per share of our common stock in this offering. We have valued such obligation at $259,550 as of the acquisition date and recorded such amount as a liability as of such date. As additional consideration, we agreed to pay the sellers an amount equal to 20% of T N S's adjusted EBITDA in excess of $1,275,000 for each of the three 12-month periods immediately following the closing date. During such 36-month period, we agreed to operate T N S in the ordinary course with the commercially-reasonable objective of maximizing the amount payable to the sellers with respect to such three 12-month periods. Finally, in the event the adjusted EBITDA of T N S for the 12-month period beginning October 1, 2012 is greater or less than $1,250,000, we also agreed to issue or cancel, as appropriate, shares of Series F Preferred Stock based on an agreed-upon formula. We valued the contingent consideration likely to be paid at $557,933 as of the date of the acquisition. In the T N S Agreement, we granted the sellers the right to put to us the shares of common stock issued at the closing for $50.00 per share, beginning 18 months after the closing and continuing for 60 days thereafter. In addition, the holders of the Series F Preferred Stock could demand that an aggregate of 3,000 shares of Series F Preferred Stock be redeemed beginning on November 27, 2012 at a redemption price of $1,000 per share, with the redemption to occur within 20 days of such request. The holders could have also requested that an additional 575 shares of Series F Preferred Stock be redeemed beginning on September 17, 2013 and that any additional shares of Series F Preferred Stock be redeemed beginning on September 17, 2014. On December 21, 2013 we entered into agreement with TNS sellers to satisfy all our outstanding obligations related to the TNS agreement. Based on the terms of that agreement we settled all our remaining obligations to the TNS sellers by converting the 1,150 shares of Series F Preferred Stock owned by such sellers, along with the settlement of the common shares with a put option, issued additional shares to settle contingent consideration and the shares to be issued in connection with our public offering which aggregated to 466,702 shares of our common stock. At the time of settlement, there was no contingent consideration outstanding. The shares issued to settle the contingent consideration arrangement resulted in a loss of $2.2 million. 47 -------------------------------------------------------------------------------- Rives-Monteiro Engineering LLC and Rives-Monteiro Leasing, LLC. On November 15, 2011, we entered into, and on December 14, 2011 we amended, a Stock Purchase Agreement (the "Rives-Monteiro Agreement") with the two members of RM Engineering and RM Leasing (collectively Rives-Monteiro) pursuant to which we acquired 49% of the membership interests of RM Engineering, were granted the right to purchase the remaining 51% of RM Engineering for $1.00 and acquired all of the membership interests of RM Leasing for the following consideration: (i) a cash payment in the amount of $300,000, of which $100,000 was paid on December 29, 2011, the date of consummation of the acquisitions, $100,000 was payable on or before March 29, 2012, and $100,000 was payable on or before June 29, 2012, (ii) 15,000 shares of common stock, (iii) the assumption of indebtedness in the aggregate amount of $211,455, (iv) an amount equal to 50% of the net income of RM Engineering during the 18-month period following date of acquisition of RM Engineering, and (v) warrants to purchase up to 1,000 additional shares of common stock at a price equal to the lower of a 25% discount to the market price of the common stock on the date of exercise or $150.00 per share, for each $500,000 of EBITDA earned by RM Engineering during the 24-month period following the date of acquisition of RM Engineering. The cash payments in the aggregate amount of $200,000 were not paid when due in March and June 2012, and the parties have agreed that such payments will be made on or prior to the closing of this offering. We valued the contingent consideration likely to be paid at $126,287 as of December 31, 2012. As of March 31, 2013, we determined, based upon the operating results of RM Engineering since the date of acquisition, that the fair value of this contingent consideration should be adjusted to $0 and no contingent consideration will be earned. AW Solutions. On April 3, 2013, we entered into a Purchase Agreement (the "AWS Agreement") with AW Solutions Inc., AW Solutions Puerto Rico, LLC and each of the equity owners of such companies pursuant to which we acquired all of the outstanding capital stock of AW Solutions Inc. and the membership interests of AW Solutions Puerto Rico, LLC for an aggregate purchase price of $8,760,097, subject to certain customary working capital adjustments. At the closing of the acquisition on April 15, 2013, we made a cash payment to the sellers in the amount of $475,000 (the "Closing Date Cash Payment"), and made a cash payment in the amount of $25,000 to an escrow agent to be held in escrow in accordance with the terms of an escrow agreement. We also issued promissory notes (the "AW Notes") to each of the sellers in the aggregate principal amount of $2,107,804. The AW Notes bear interest at the rate of 0.22% per annum and are payable within five business days of the earlier of (i) the date of consummation of this offering or (ii) September 30, 2013. On the maturity date of the AW Notes, 5% of the then-outstanding principal balance of the AW Notes will be delivered by us to the escrow agent to be held in escrow. The AW Notes are secured by a lien on the accounts receivable of AW Solutions as of the closing date pursuant to a security agreement among the sellers, AW Solutions and our company. If we default on the AW Notes, the sellers may exercise their lien on the accounts receivable of AW Solutions. As additional consideration for the purchase of AW Solutions, we issued to the sellers an aggregate of 203,735 shares of our common stock. Any amounts remaining held in escrow by the escrow agent not subject to any claims shall be released to the sellers nine months after the closing date. The AWS Agreement provides for certain earn-out payments to the Sellers based on the first and second anniversary EBITDA of AW Solutions. Following the first anniversary of the closing date, we will calculate the EBITDA of AW Solutions for the twelve-month period beginning on the closing date and ending on the first anniversary of the closing date (the "First Anniversary EBITDA"), which will be subject to review by the sellers in accordance with the AWS Agreement. If required, we will make an earn-out payment to the Sellers based on the First Anniversary EBITDA as follows (the "First EBITDA Adjustment"): (i) if the First Anniversary EBITDA is less than $2,000,000, the First EBITDA Adjustment will be zero; (ii) if the First Anniversary EBITDA is equal to or greater than $2,000,000 and less than or equal to $3,000,000, then the First EBITDA Adjustment will be equal to the First Anniversary EBITDA and will be paid by us to the sellers in cash; 48-------------------------------------------------------------------------------- (iii) if the First Anniversary EBITDA is greater than $3,000,000 and less than or equal to $4,000,000, then the First EBITDA Adjustment will be equal to 1.5 times the First Anniversary EBITDA and will be paid by us to the sellers in cash; (iv) if the First Anniversary EBITDA is greater than $4,000,000 and less than or equal to $5,000,000, then the First EBITDA Adjustment will be equal to 2.0 times the First Anniversary EBITDA, of which 50% will be paid by us to the sellers in cash and 50% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the first anniversary of the closing date; or (v) if the First Anniversary EBITDA is greater than $5,000,000, then the First EBITDA Adjustment will be equal to 2.25 times the First Anniversary EBITDA, of which 50% will be paid by us to the sellers in cash and 50% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the first anniversary of the closing date. Following the second anniversary of the closing date, we will calculate the EBITDA of AW Solutions for the twelve-month period beginning on the first anniversary of the closing date and ending on the second anniversary of the closing date (the "Second Anniversary EBITDA"), which will be subject to review by the sellers in accordance with the AWS Agreement. We will make an earn-out payment to the sellers based on the Second Anniversary EBITDA as follows (the "Second EBITDA Adjustment"): (i) if the Second Anniversary EBITDA is less than or equal to the First Anniversary EBITDA, then the Second EBITDA Adjustment will be zero; (ii) if the Second Anniversary EBITDA exceeds the First Anniversary EBITDA (the "EBITDA Growth Amount") by an amount less than $1,000,000, the Second EBITDA Adjustment will be equal to 2.0 times the EBITDA Growth Amount and will be paid us to the sellers in cash; (iii) if the EBITDA Growth Amount is equal to or greater than $1,000,000 and less than $3,000,000, then the Second EBITDA Adjustment will be equal to 2.25 times the EBITDA Growth Amount, of which 88.88% will be paid by us to the sellers in cash and 11.12% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on the second anniversary of the closing date; or (iv) if the EBITDA Growth Amount is equal to or greater than $3,000,00, then the Second EBITDA Adjustment will be equal to 2.5 times the EBITDA Growth Amount, of which 80% will be paid by us to the sellers in cash and 20% will be paid by the issuance to the sellers of unregistered shares of common stock at a price per share equal to the closing price of the common stock on second anniversary of the closing date. On December 31, 2013, we evaluated the amount of contingent consideration to be paid and increased the amount by $1.7 million to $4.4 million. RentVM. On February 3, 2014, we entered into a Stock Purchase Agreement (the "RentVM Agreement") with RentVM and the stockholders of RentVM pursuant to which we acquired all the outstanding capital stock of RentVM. In consideration for such shares of capital stock, at closing we issued 400,000 shares of our common stock, of which (i) an aggregate of 331,601 of the shares were issued to the sellers and (ii) 68,399 of the shares were placed in escrow (the "Escrow Shares"). The Escrow Shares secure, among other things, the sellers' indemnification obligations under the RentVM Agreement. Notwithstanding the foregoing, provided no claim for indemnity has been made, or if a claim has been made and there are sufficient Escrow Shares remaining to satisfy such claim, the sellers may request a release of up to 25% of the remaining Escrow Shares to cover personal tax liabilities associated with the acquisition. Up to and including the 90th calendar day following the closing date of the acquisition, we have the option to purchase from the sellers, on a pro rata basis, for an aggregate option purchase price of $1,000,000 in cash, a number of shares of our common stock equal to the quotient of $1,000,000 divided by $14.62 (the closing price of our common stock on the trading day immediately preceding the date of the RentVM Agreement). Integration Partners - NY Corporation. Effective as of January 1, 2014, we consummated the acquisition of all of the outstanding capital stock of IPC, pursuant to the terms of a Stock Purchase Agreement, dated as of December 12, 2013 and amended on January 1, 2014 (the "IPC Agreement"), by and among IPC, the sole stockholders of IPC and our company. The purchase price for the acquisition was paid as follows: ? an aggregate of $12,509,747 was paid to owners of IPC; ? a convertible promissory note was issued to an owner of IPC in the original principal amount of $6,254,873; ? 45,676 shares of our common stock will be issued to an owner of IPC or his designee(s); ? 5,886 shares of our common stock will be issued to certain owners of IPC or their respective designee(s); and ? $941,594 and 47,080 shares of our common stock was placed in escrow to secure the sellers' indemnification and certain other obligations under the IPC Agreement. 49-------------------------------------------------------------------------------- As additional earn-out consideration, pursuant to the terms of the IPC Agreement, we will pay to a former owner of IPC an amount equal to (i) the product of 0.6 multiplied by the EBITDA of IPC for the 12-month period beginning on January 1, 2014 (the "Forward EBITDA"), plus (ii) in the event that the Forward EBITDA exceeds the closing trailing-twelve-month EBITDA by 5.0% or more, an amount equal to 2.0 multiplied by this difference, which amount will be payable in cash, or at our election, shares of our common stock. We will record any contingent consideration paid as compensation expense in the period earned. The promissory note we issued at closing accrues interest at the rate of 8% per annum, and all principal and interest accruing thereunder is due and payable on December 31, 2014. At the election of the holder of such promissory note, such promissory note is convertible into shares of our common stock at a conversion price of $16.99 per share (subject to equitable adjustments for stock dividends, stock splits, recapitalizations and other similar events). Beginning on July 1, 2014, if our common stock is trading at a price of greater than or equal to $16.99 for ten consecutive trading days, we may elect to force the conversion of such promissory note. Proceeds from Equity Issuances. In the years ended December 31, 2013 and 2012, we raised net proceeds of $5.8 million and $6.9 million, respectively, through public and private sales of equity securities. Accounts Receivable We had gross accounts receivable at December 31, 2013 and 2012 of $8.6 million and $8.2 million, respectively. Accounts receivable at December 31, 2012 was significant relative to the annual revenues for the year ended December 31, 2012 for the following reasons: ? We acquired ERFS on December 17, 2012. The revenue we recorded for ERFS for the year ended December 31 2012 was $146,036, while the accounts receivable for ERFS included in our consolidated accounts receivable at December 31, 2012 was $821,357. ? We acquired T N S on September 17, 2012. The revenue that was included for T N S from September 17, 2012 through December 31, 2012 was $1,042,367, while the amount of accounts receivable included in our consolidated accounts receivable on December 31, 2012 was $558,849. ? We acquired the ADEX entities on September 17, 2012. The revenue that was included for the ADEX entities from September 17, 2012 through December 31, 2012 was $10,577,197, while the amount of accounts receivable included in our consolidated accounts receivable on December 31, 2012 was $6,758,439. Our days sales outstanding calculated on an annual basis was not meaningful at December 31, 2012 because we had owned the companies noted above only for a short period. Our days sales outstanding as of December 31, 2013 was 61 days, which we believe is more representative of what should be expected going forward. Working Capital At December 31, 2013, we had working capital of approximately $4.2 million, as compared to a working capital deficit of approximately $4.7 million at December 31, 2012. The increase of $8.9 million in our working capital from December 31, 2012 to December 31, 2013 was primarily the result of an increase in cash of approximately $17.3 million resulting primarily from the proceeds of our sale of $11.6 million aggregate principal amount of the Convertible Debentures and $2.0 million of additional debt securities in December 2013. The increase in current assets was offset, in part, by the increase in current liabilites at December 31, 2013 that was due primarily to an increase in accounts payable and accrued expenses of $5.2 million. The increase in accounts payable was primarily the result of increased legal and accounting fees and expenses of approximately $1.0 million, a significant portion of which related to services provided for our public offering of equity securities in the fourth quarter of 2013, accrued interest of $1.7 million and accrued dividends on preferred stock of $0.5 million. The increase in our working capital at December 31, 2013 was attributable, in part, to our requirement for a cash payment of approximately $12.5 million in connection with our acquisition of IPC on January 1, 2014. Giving effect to such cash payment on January 1, 2014 and to the increase in our working capital in the amount of approximately $0.8 million due to our consolidation of the working capital of IPC as of such date, on a pro forma basis we would have had a working capital deficit of approximately $7.6 million at December 31, 2013. We raised $11.6 million through the issuance of the Convertible Debentures, and an additional $2.0 million through the sale of debt securities, in December 2013. The proceeds of such financings were used for the cash portion of the purchase price of IPC. 50--------------------------------------------------------------------------------On or prior to December 31, 2014, we have obligations relating to the payment of indebtedness as follows: ? $3,925,000 with respect to our note payable to MMD Genesis, which is due in June 2014; ? approximately $259,000 with respect to the bank line of credit of RM Engineering, which is due in July 2014; ? an amount payable to the sellers of AW Solutions in May 2014, which will be calculated based upon the EBITDA of AW Solutions and for which we have recorded a contingent liability for contingent consideration in the amount of approximately $2.6 million ; ? $5.3 million payable to the holders of the Convertible Debentures, which is payable in six monthly installments commencing in July 2014; and ? $6.3 million payable to a seller of IPC in respect of a convertible promissory note that matures on December 31, 2014. We anticipate meeting our cash obligations on our indebtedness that is payable on or prior to December 31, 2014 from earnings from operations, including in particular the operations of ADEX, T N S, AW Solutions and IPC, each of which we recently acquired, and possibly from the proceeds of additional indebtedness and equity raises. We anticipate meeting our cash obligations in connection with our acquisitions of VaultLogix and Telco from the sale of additional debt or equity securities. There can be no assurance, however, that we will be able to obtain any additional financing on terms that are acceptable to us, if at all. We anticipate that our earnings from operations and a portion of the proceeds from the additional financings discussed above will be sufficient to fund our debt repayment obligations. If we are not successful in obtaining additional financing, we expect that we will be able to renegotiate and extend certain of our notes payable as required to enable us to meet our debt obligations as they become due, although there can be no assurance we will be able to do so. 51 --------------------------------------------------------------------------------Cash Flows. The following summary of our cash flows for the periods indicated has been derived from our historical consolidated financial statements, which are included elsewhere in this report: Summary of Cash Flows Year ended December 31, 2013 2012 Net cash provided by (used in) operations $ 2,792,934 $ (2,975,942 ) Net cash used in investing activities (233,377 ) (13,735,393 ) Net cash provided by financing activities 15,053,126 17,269,028 Net cash used in operating activities. We have historically experienced cash deficits from operations as we continued to expand our business and sought to establish economies of scale. Our largest uses of cash for operating activities are for general and administrative expenses. Our primary source of cash flow from operating activities is cash receipts from customers. Our cash flow from operations will continue to be affected principally by the extent to which we grow our revenues and increase our headcount. Net cash provided by operating activities for the year ended December 31, 2013 of $2.8 million was primarily attributable to a net loss of $24.3 million offset by increases in the fair value of our derivative liability and our accounts payable and accrued expenses of $14.2 million and $6.3 million, respectively. Net cash used in operating activities for the year ended December 31, 2012 of $3.0 million was primarily attributable to a net loss of $1.2 million and an increase in net accounts receivable of $1.4 million primarily due to revenue growth for the year ended December 31, 2012, which was offset in part by an increase in accounts payable and accrued expenses of $2.1 million. Net cash used in investing activities. Net cash used in investing activities for the years ended December 31, 2013 and 2012 was $1.2 million and $13.7 million, respectively, consisting primarily of cash used for acquisitions and purchases of capital equipment. Net cash provided by financing activities. Net cash provided by financing activities for the year ended December 31, 2013 was $15.1 million, which resulted primarily from the proceeds of $17.1 million we received from the sale of the Convertible Debentures and other borrowings, the public offering of our common stock which generated $2.8 million, net of issuance costs, and the proceeds of $0.8 million we received from the sale of preferred stock, offset in part by repayments of notes and loans payable of $3.0 million, increase in deferred loan costs of $1.8 million and the redemption of outstanding preferred stock of $3.0 million. Net cash provided by financing activities for the year ended December 31, 2012 was $17.3 million, which resulted primarily from the proceeds from the loans under the MidMarket Loan Agreement and the sale of preferred shares. Rental Obligations. We and our operating subsidiaries have real property leases as described in this report under Item 2. - Properties. These leases expire on various dates through 2017. The future minimum obligation during each year through 2017 under the leases with non-cancelable terms in excess of one year is as follows: Years Ended December 31, Future Minimum Lease Payments 2014 $ 449,567 2015 219,705 2016 112,641 2017 66,710 Total $ 848,623 52--------------------------------------------------------------------------------Capital expenditures We had capital expenditures of $124,273 and $89,258 for the years ended December 31, 2013 and 2012, respectively. We expect our capital expenditures for the 12 months ending December 31, 2014 to be consistent with our prior spending. These capital expenditures will be primarily utilized for equipment needed to generate revenue and for office equipment. We expect to fund such capital expenditures out of our working capital. Off-balance sheet arrangements During the years ended December 31, 2013 and 2012, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Contingencies We are involved in claims and legal proceedings arising from the ordinary course of our business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and the amount can be reasonably estimated. If these estimates and assumptions change or prove to be incorrect, it could have a material impact on our financial statements. Critical accounting policies and estimates The discussion and analysis of our financial condition and results of operations are based on our historical and pro forma consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make certain estimates and assumptions that affect the amounts reported therein and accompanying notes. On an ongoing basis, we evaluate these estimates and assumptions, including those related to recognition of revenue for costs and estimated earnings in excess of billings, the fair value of reporting units for goodwill impairment analysis, the assessment of impairment of intangibles and other long-lived assets, income taxes, asset lives used in computing depreciation and amortization, allowance for doubtful accounts, stock-based compensation expense for performance-based stock awards derivatives, contingent consideration and accruals for contingencies, including legal matters. These estimates and assumptions require the use of judgment as to the likelihood of various future outcomes and as a result, actual results could differ materially from these estimates. We have identified the accounting policies below as critical to the accounting for our business operations and the understanding of our results of operations because they involve making significant judgments and estimates that are used in the preparation of our historical and pro forma consolidated financial statements. The impact of these policies affects our reported and expected financial results and are discussed in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." We have discussed the development, selection and application of our critical accounting policies with the Audit Committee of our board of directors, and the Audit Committee has reviewed the disclosure relating to our critical accounting policies in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Other significant accounting policies, primarily those with lower levels of uncertainty than those discussed below, are also important to understanding our historical consolidated financial statements. The notes to our consolidated financial statements in this report contain additional information related to our accounting policies, including the critical accounting policies described herein, and should be read in conjunction with this discussion. 53 --------------------------------------------------------------------------------Emerging Growth Company. On April 5, 2012, the Jumpstart Our Business Startups Act, or the JOBS Act, was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company," we may delay adoption of new or revised accounting standards applicable to public companies until the earlier of the date that (i) we are no longer an emerging growth company or (ii) we affirmatively and irrevocably opt out of the extended transition period for complying with such new or revised accounting standards. We have elected not to take advantage of the benefits of this extended transition period. As a result, our financial statements will be comparable to those of companies that comply with such new or revised accounting standards. Upon issuance of new or revised accounting standards that apply to our financial statements, we will disclose the date on which we will adopt the recently-issued accounting guidelines. REVENUE RECOGNITION Our revenues are generated from two reportable segments, specialty contracting services and telecommunication staffing services. We recognize revenue only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured. The specialty contracting services segment is comprised of TNS, Tropical, AW Solutions and RM Engineering. Specialty contracting services revenues are derived from contracted services to provide technical engineering services along with contracting services to commercial and governmental customers. The contracts of TNS, Tropical and RM Engineering provide that payment for our services may be based on either 1) direct labor hours at fixed hourly rates or 2) fixed-price contracts. The services provided under the contracts are generally provided within a month. Occasionally, the services may be provided over a period of up to six months. AW Solutions recognizes revenue using the percentage of completion method. Revenues and fees on these contracts are recognized specifically utilizing the efforts-expended method, which uses measures such as task duration and completion. The efforts-expended approach is an input method used in situations where it is more representative of progress on a contract than the cost-to-cost or the labor-hours methods. We use labor hours as the basis for the percentage of completion calculation, which is measured principally by the percentage of labor hours incurred to date for each contract to the estimated total labor hours for each contract at completion. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. Changes in job performance conditions and final contract settlements may result in revisions to costs and income, which are recognized in the period revisions are determined. AW Solutions also generates revenue from service contracts with certain customers. These contracts are accounted for under the proportional performance method. Under this method, revenue is recognized in proportion to the value provided to the customer for each project as of each reporting date. The revenues of the telecommunication staffing service segment, which is comprised of the ADEX subsidiaries, are derived from contracted services to provide technical engineering and management solutions to large voice and data communications providers, as specified by their clients. The contracts provide that payments made for our services may be based on either 1) direct labor hours at fixed hourly rates or 2) fixed-price contracts. The services provided under the contracts are generally provided within a month. Occasionally, the services may be provided over a period of up to four months. If it is anticipated that the services will span a period exceeding one month, depending on the contract terms, we will provide either progress billing at least once a month or upon completion of the clients' specifications. The aggregate amount of unbilled work-in-progress recognized as revenues was insignificant at December 31, 2013 and 2012. We sometimes require customers to provide a deposit prior to beginning work on a project. When this occurs, the deposit is recorded as deferred revenue and is recognized in revenue when the work is complete. During 2013 and 2012, we did not recognize any revenue from cloud-based services. Allowances for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. Management analyzes the collectability of accounts receivable balances each period. This analysis considers the aging of account balances, historical bad debt experience, changes in customer creditworthiness, current economic trends, customer payment activity and other relevant factors. Should any of these factors change, the estimate made by management may also change, which could affect the level of our future provision for doubtful accounts. We recognize an increase in the allowance for doubtful accounts when it is probable that a receivable is not collectable and the loss can be reasonably estimated. Any increase in the allowance account has a corresponding negative effect on our results of operations. We believe that none of our significant customers were experiencing financial difficulties that would materially impact our trade accounts receivable or allowance for doubtful accounts as of December 31, 2013 and 2012. Goodwill and Intangible Assets. As of December 31, 2013 and 2012, we had goodwill in the amount of $17.1 million and $14.8 million, respectively. We did not recognize any goodwill impairment during the years ended December 31, 2013 or 2012. 54 -------------------------------------------------------------------------------- We account for goodwill in accordance with Financial Accounting Standards Board (FASB) ASC Topic 350, Intangibles-Goodwill and Other (ASC Topic 350). Our reporting units and related indefinite-lived intangible assets are tested annually during the fourth fiscal quarter of each year in accordance with ASC Topic 350 in order to determine whether their carrying value exceeds their fair value. In addition, they are tested on an interim basis if an event occurs or circumstances change between annual tests that would more likely than not reduce their fair value below carrying value. If we determine the fair value of goodwill or other indefinite-lived intangible assets is less than their carrying value as a result of the tests, an impairment loss is recognized. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred. In accordance with ASC Topic 360, Impairment or Disposal of Long-Lived Assets, we review finite-lived intangible assets for impairment whenever an event occurs or circumstances change which indicates that the carrying amount of such assets may not be fully recoverable. Recoverability is determined based on an estimate of undiscounted future cash flows resulting from the use of an asset and its eventual disposition. An impairment loss is measured by comparing the fair value of the asset to its carrying value. If we determine the fair value of an asset is less than the carrying value, an impairment loss is incurred. Impairment losses, if any, are reflected in operating income or loss in the consolidated statements of operations during the period incurred. We use judgment in assessing if goodwill and intangible assets are impaired. Estimates of fair value are based on our projection of revenues, operating costs, and cash flows taking into consideration historical and anticipated future results, general economic and market conditions, as well as the impact of planned business or operational strategies. To measure fair value, we employ a combination of present value techniques which reflect market factors. Changes in our judgments and projections could result in significantly different estimates of fair value potentially resulting in additional impairments of goodwill and other intangible assets. Our goodwill resides in multiple reporting units that are aggregated into our two reporting segments for our goodwill impairment testing. One reporting segment is composed of our telecommunications staffing services, which is comprised of the ADEX entities. The other reporting segment, specialty contracting services, is an aggregation of our TNS, Tropical, RM Engineering and AW Solutions reporting units. The profitability of individual reporting units may suffer periodically from downturns in customer demand and other factors resulting from the cyclical nature of our business, the high level of competition existing within our industry, the concentration of our revenues from a limited number of customers, and the level of overall economic activity. During times of slowing economic conditions, our customers may reduce capital expenditures and defer or cancel pending projects. Individual reporting units may be relatively more impacted by these factors than us as a whole. As a result, demand for the services of one or more of our reporting units could decline resulting in an impairment of goodwill or intangible assets in one of our reporting segments. Certain of our business units also have other intangible assets, including customer relationships, trade names and non-compete agreements. As of December 31, 2013 and 2012, we believed the carrying amounts of these intangible assets were recoverable. However, if adverse events were to occur or circumstances were to change indicating that the carrying amount of such assets may not be fully recoverable, the assets would be reviewed for impairment and the assets could be impaired. Stock-Based Compensation. Our stock-based award programs are intended to attract, retain and reward employees, officers, directors and consultants, and to align stockholder and employee interests. We granted stock-based awards to individuals in both 2013 and 2012. Our policy going forward will be to issue awards under our 2012 Employee Incentive Plan and Employee Stock Purchase Plan. Compensation expense for stock-based awards is based on the fair value of the awards at the measurement date and is included in operating expenses. The fair value of stock option grants is estimated on the date of grant using the Black-Scholes option pricing model based on certain assumptions including: expected volatility based on the historical price of our stock over the expected life of the option, the risk-free rate of return based on the United States treasury yield curve in effect at the time of the grant for the expected term of the option, the expected life based on the period of time the options are expected to be outstanding using historical data to estimate option exercise and employee termination; and dividend yield based on history and expectation of dividend payments. Stock options generally vest ratably over a three-year period and are exercisable over a period up to ten years. The fair value of restricted stock is estimated on the date of grant and is generally equal to the closing price of our common stock on that date. The price of our common stock price has varied greatly during the years ended December 31, 2013 and 2012. Some of the factors that influenced the market price of our stock during these periods include: ? the closing of four acquisitions (ADEX, T N S, ERFS and AW Solutions in 2012 and 2013); ? increasing indebtedness to fund such acquisitions; 55-------------------------------------------------------------------------------- ? the entering into of a definitive agreement to acquire IPC and Telco; ? the approval and eventual effectuation of a 1-for-125 reverse stock split in January 2013 and a one-for-four reverse stock split in August 2013, which caused uncertainty and volatility; and ? our stock being very thinly traded prior to the listing of our common stock on the Nasdaq Capital Market in October 2013, resulting in large fluctuations. The total amount of stock-based compensation expense ultimately is based on the number of awards that actually vest and fluctuates as a result of performance criteria, as well as the vesting period of all stock-based awards. Accordingly, the amount of compensation expense recognized during any fiscal year may not be representative of future stock-based compensation expense. In accordance with ASC Topic 718, Compensation - Stock Compensation (ASC Topic 718), compensation costs for performance-based awards are recognized over the requisite service period if it is probable that the performance goal will be satisfied. We use our best judgment to determine probability of achieving the performance goals in each reporting period and recognize compensation costs based on the number of shares that are expected to vest. The following tables summarize our stock-based compensation for the years ended December 31, 2013 and 2012. Year Ended December 31, 2013 Closing Stock Fair Value Shares of Price Fair Value of Instrument Date Common Stock on Grant Date Per Share Granted 2/6/2013 5,000 $ 2.88 $ 2.88 $ 14,400 2/15/2013 6,250 3.38 3.38 21,125 3/26/2013 5,000 3.00 3.00 15,000 12/4/2013 139,500 9.59 9.59 1,337,805 12/30/2013 11,700 17.41 17.41 203,697 Year Ended December 31, 2012 Closing Stock Fair Value Shares of Price Fair Value of Instrument Date Common Stock on Grant Date Per Share Granted 8/8/2012 4,000 $ 6.00 $ 6.00 $ 24,000 9/19/2012 6,000 8.50 8.50 51,000 10/9/2012 8,000 12.05 12.05 96,400 10/19/2012 5,000 13.50 13.50 67,500 11/16/2012 10,000 10.00 10.00 100,000 Since December 31, 2013, there have been no grants of stock-based compensation. Income Taxes. We account for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. ASC Topic 740, Income Taxes (ASC Topic 740), prescribes a two-step process for the financial statement recognition and measurement of income tax positions taken or expected to be taken in an income tax return. The first step evaluates an income tax position in order to determine whether it is more likely than not that the position will be sustained upon examination, based on the technical merits of the position. The second step measures the benefit to be recognized in the financial statements for those income tax positions that meet the more likely than not recognition threshold. ASC Topic 740 also provides guidance on derecognition, classification, recognition and classification of interest and penalties, accounting in interim periods, disclosure and transition. Under ASC Topic 740, companies may recognize a previously-unrecognized tax benefit if the tax position is effectively (rather than "ultimately") settled through examination, negotiation or litigation. 56--------------------------------------------------------------------------------Contingencies and Litigation. In the ordinary course of our business, we are involved in certain legal proceedings. ASC Topic 450, Contingencies (ASC Topic 450), requires that an estimated loss from a loss contingency should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued, we evaluate, among other factors, the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. If only a range of probable loss can be determined, we accrue for our best estimate within the range for the contingency. In those cases where none of the estimates within the range is better than another, we accrue for the amount representing the low end of the range in accordance with ASC Topic 450. As additional information becomes available, we reassess the potential liability related to our pending contingencies and litigation and revise our estimates. Revisions of our estimates of the potential liability could materially impact our results of operations. Additionally, if the final outcome of such litigation and contingencies differs adversely from that currently expected, it would result in a charge to earnings when determined. Distinguishing of Liabilities From Equity. We rely on the guidance provided by ASC 480, Distinguishing Liabilities from Equity, to classify certain redeemable and/or convertible instruments, such as our preferred stock. We first determine whether the particular financial instrument should be classified as a liability. We will determine the liability classification if the financial instrument is mandatorily redeemable, or if the financial instrument, other than outstanding shares, embodies a conditional obligation that we must or may settle by issuing a variable number of our equity shares. Once we determine that the financial instrument should not be classified as a liability, we determine whether the financial instrument should be presented under the liability section or the equity section of the balance sheet ("temporary equity"). We will determine temporary equity classification if the redemption of the preferred stock or other financial instrument is outside our control (i.e. at the option of the holder). Otherwise, we account for the financial instrument as permanent equity. Initial Measurement. We record our financial instruments classified as liability, temporary equity or permanent equity at issuance at the fair value, or cash received. Subsequent Measurement. We record the fair value of our financial instruments classified as liabilities at each subsequent measurement date. The changes in fair value of our financial instruments classified as liabilities are recorded as other expense/income. Temporary Equity. At each balance sheet date, we re-evaluate the classification of our redeemable instruments, as well as the probability of redemption. If the redemption amount is probable or the instrument is currently redeemable, we record the instrument at its redemption value. Upon issuance, the initial carrying amount of a redeemable equity security it its fair value. If the instrument is redeemable currently at the option of the holder, it will be adjusted to its maximum redemption amount at each balance sheet date. If the instrument is not redeemable currently and it is not probable that it will become redeemable, it is recorded at its fair value. If it is probable the instrument will become redeemable it will be recognized immediately at its redemption value. The resulting increases or decreases in the carrying amount of a redeemable instrument will be recognized as adjustments to additional paid-in capital. 57 --------------------------------------------------------------------------------Business Combinations. We account for our business combinations under the provisions of ASC 805-10, Business Combinations (ASC 805-10), which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed, including non-controlling interests, are recorded at the date of acquisition at their respective fair values. ASC 805-10 also specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combinations and are expensed as incurred. If the business combination provides for contingent consideration, we record the contingent consideration at fair value at the acquisition date and any changes in fair value after the acquisition date are accounted for as measurement-period adjustments if they pertain to additional information about facts and circumstances that existed at the acquisition date and that we obtained during the measurement period. Changes in fair value of contingent consideration resulting from events after the acquisition date, such as earn-outs, are recognized as follows: (i) if the contingent consideration is classified as equity, the contingent consideration is not re-measured and its subsequent settlement is accounted for within equity, or (ii) if the contingent consideration is classified as an asset or a liability, the changes in fair value are recognized in earnings. |